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June 29, 2012

SEC, NASAA to Small Businesses: Hold Off on Crowdfunding

‘Crowdfunding is not yet legal until the commission appoints rules,’ says SEC's Kim

The Securities and Exchange Commission (SEC) and state regulators are warning small businesses and entrepreneurs to wait to join the crowd.

In an advisory on Wednesday, state regulators warned small businesses that they should wait until the SEC has finalized its crowdfunding rules before offering shares in their ventures for public sale. “Until that time, federal and state securities law prohibitions remain in place against publicly accessible Internet securities offerings,” said the North American Securities Administrators Association (NASAA), a state regulators’ trade group.

Indeed, the chief counsel of the SEC’s Division of Corporation Finance, Thomas Kim, told the SEC’s Investor Advisory Committee during its first meeting in May that as part of the Jumpstart Our Business Startups (JOBS) Act, which was signed into law in April, the division is grappling with the issue of equity crowdfunding, which allows investors of any net worth to fund entrepreneurial startups. “Crowdfunding is not yet legal until the commission appoints rules,” Kim said.

The JOBS Act directs the SEC to adopt rules within 270 days to implement a new exemption to allow entrepreneurs and small businesses to offer investments in their ventures through crowdfunding. But Kim said that a timeframe for an SEC rulemaking on equity crowdfunding is “challenging.”

SEC Chairwoman Mary Schapiro told a congressional panel on Thursday that staff in the agency’s divisions of Corporation Finance and Trading and Markets as well as agency economists are “working closely together” to develop recommendations for the commission.

While crowdfunding has been going on for a number of years as a form of raising money through donations from donors, the SEC must formalize rules for equity crowdfunding, which, as set out in the JOBS Act, allows capital raising through investors via Internet funding portals.

NASAA’s advisory highlights concerns for small businesses and entrepreneurs seeking to raise investment capital through crowdfunding, which began as a way for the public to donate small amounts of money, often through social networking websites, to help small startups finance their projects.

Through the JOBS Act, small businesses and entrepreneurs will be able to tap into the “crowd” in search of investments to finance their business ventures.

NASAA’s advisory also notes that the JOBS Act only exempts crowdfunding equity offerings from securities law registration requirements. “The requirements of federal and state securities laws regarding disclosures, including disclosures of all material facts and risks to investors, remains in place,” the advisory says. “If you do not comply with these disclosure requirements, you and your business can be liable for securities fraud and subject to private lawsuits as well as administrative enforcement actions.”

Jack Herstein, NASAA president and assistant director of the Nebraska Department of Banking & Finance Bureau of Securities, noted that “small businesses are important to the nation’s economic growth and the crowdfunding concept has the potential to provide legitimate small, innovative enterprises with access to capital that might not otherwise be available.”

In May, the SEC staff published responses to frequently asked questions related to the crowdfunding exemption to provide guidance on the implementation of the Title III provisions within the JOBS Act. In April, the SEC issued a notice reminding market participants that this title was not yet effective.